Xtrackers Euro Stoxx 50 ETF 1C GBP (LSE:XESC) - ETF price


ETF Report

Xtrackers Euro Stoxx 50 UCITS ETF 1C (GBP) XESC

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PortfolioConstruction

The Euro Stoxx 50 Index includes 50 large-cap companies from 12 developed countries in the eurozone. To be eligible for inclusion, a company must be headquartered in a country of the European Economic and Monetary Union. In order to construct the index, Stoxx identifies stocks that represent the largest 60% of each Super Sector (there are 19) by free-float market cap. It ranks the stocks on the resulting list by free-float-adjusted market cap and targets the largest 50 for inclusion in the index. Each component is capped at a maximum of 10% of the index’s overall value. In order to reduce unnecessary turnover, the largest 40 stocks are included in the index. The remaining 10 stocks are chosen from stocks with a rank between 41 and 60. This adjustment, together with market-cap weighting, has kept the index’s turnover low. Its turnover was in the single digits in each of the past five years. At the time of writing, financials is the biggest sector represented, comprising 17% of the index's value, followed by consumer discretionary (13%) and industrials (13%). French and German companies combined account for about 70% of the index. Spanish and Dutch companies represent another 20%, and the remainder is spread amongst another eight countries. The index is well-balanced from a single-stock perspective. Its top constituents are Total, SAP, and Sanofi, with a 3%-6% weighting each.

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Fees

At 0.09%, this fund's ongoing charge is at the low end of the range for ETFs tracking the Euro Stoxx 50 Index. Today, there are rival ETFs charging fees as low as 0.05%. That said, one should look beyond fees and examine the total holding cost per year, as measured by the tracking difference (fund return less index return). Most, if not all, Euro Stoxx 50 ETFs exhibit positive tracking differences (meaning they outperform the index) because of differences in withholding tax treatment between the funds' and the index's methodology (the funds enjoy a better withholding tax rate on dividend than the Euro Stoxx 50 Net Return Index). Xtrackers ETF Euro Stoxx 50 ETF has outperformed its benchmark over the trailing three years by an around 0.50% per year. Additionally, an ETF investor will typically have to pay trading costs, including bid-offer spreads and brokerage fees, when buy and sell orders are placed for ETF shares.

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FundConstruction

The ETF uses full replication to track the performance of the Euro Stoxx 50 Net Total Return Index. The fund holds all the securities within the index in the same weightings stipulated by the index. The ETF may also hold a small amount (typically less than 2% of the portfolio’s value) of index futures contracts to mitigate cash drag caused by dividend payments. The fund engages in securities lending to help improve tracking performance. Gross lending revenues are split 70/30 between the fund and DB Agency Securities Lending, which serves as lending agent covers all the operational costs associated with the securities-lending transactions (net returns to the fund have been 0.04% over the trailing year). As a general rule, no more than 50% of the fund's assets can be lent out at any given time. Although this activity can help to fully offset holding costs, it exposes investors to an element of counterparty risk. To protect the fund, borrowers are requested to post collateral greater than the loan value. At the time of writing, the collateral basket is composed of high-grade (Aaa or Aa2) euro-denominated government debt and is valued at 122% of fund NAV. As an additional protection measure, Deutsche Bank provides borrower default indemnification: That is, in the event of a borrower insolvency or default, the bank will indemnify the fund for any shortfall between the proceeds from collateral liquidation and the market value of the securities on loan. Xtrackers is nearing the end of a transitional period in which it has made strides towards becoming a stand-alone asset manager. This process has involved severing links with Deutsche Bank’s investment banking arm, in-housing the management of all its ETFs, and converting a number of products from synthetic to physical replication. The recent rebranding exercise is perhaps the most visible result of this shift. The process, which has been managed smoothly, has required a significant investment in both personnel and infrastructure. Although the management team remains relatively new as a unit, the calibre of recruits has been high, and the systems that have been implemented represent an upgrade on those they have replaced.

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Suitability

The Euro Stoxx 50 Index’s mega-cap focus doesn’t give us confidence in Xtrackers Euro STOXX 50 ETF’s ability to outperform category peers over a full market cycle on a risk-adjusted basis. It has earned a Morningstar Analyst Rating of Neutral. 

The Euro Stoxx 50 Index is a widely followed benchmark to gauge investor sentiment on eurozone equities. But with only 50 components capturing 60% of the euro area’s total market value, it stands as a narrow investment proposition that does not represent the opportunity set available to investors. The eurozone large-cap Morningstar Category includes passive and active funds that are better diversified.

Because of its concentration in giant-caps--and lack of tailwind generally provided by "smaller" caps at times of strong economic growth--the fund is unlikely to outperform its category peers over the long term.

In line with this prediction the fund has lagged its surviving peers on a risk-adjusted basis over 10 years. The fact that risk-adjusted returns have been above average during the trailing three- and five-year periods demonstrates that depending on the market cycle, returns may vary over shorter periods. Specifically, the fund has held up better in times of market downturns and uncertainty when investors tend to flee to the safety of blue chips.

That said, there is no shortage of passive funds offering exposure to the popular Euro Stoxx 50 Index, many of which have seen their fees slashed in recent years. At 0.09%, the fully replicated Xtrackers ETF Euro Stoxx 50 ETF is one of the cheapest.

Like most Euro Stoxx 50 Index trackers, this ETF outperforms its benchmark because it enjoys a better withholding tax rate on dividends than the Euro Stoxx 50 Net Return Index. It also benefits from securities-lending activities.

Despite its ultralow fee, this ETF’s narrow mega-cap mandate undermines its long-term investment prospects and makes it a less-than-ideal vehicle to gain access to eurozone large-caps. This thesis is supported by the lacklustre risk-adjusted performance it has achieved over longer time horizons.

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Fundamental View

Passive investors in eurozone equities have a small range of cap-weighted funds from which to choose. Of these, the most tracked index by ETFs in Europe is the EURO STOXX 50 Index. Tracking only the 50 largest companies in the monetary union, the index is extremely narrow and provides only targeted mega-cap exposure.

Broader in terms of size, with around 240 constituents, is the MSCI EMU Index. Like other MSCI indexes, it captures approximately 85% of the free-float-adjusted market capitalisation and is designed to measure the performance of the large- and mid-cap segments of the eurozone equity market.

More comprehensive still is the EURO STOXX Index, which spans around 300 constituents. It represents a eurozone-screened subset of the wider STOXX Europe 600 Index and is the broadest passive index currently tracked by European funds.

We hold a general preference for a broader-cap-weighted index as those tend to be more representative of the total market and therefore a more comprehensive building block. The broader the index, the harder it becomes for active managers to boost relative returns over the long term through stock selection.

Over the trailing five-, 10-, and 15-year periods (to March 2019), index Sharpe ratios have matched theoretical predictions remarkably well. The broadest offering, the EURO STOXX Index, has been the top performer, with the highest Sharpe ratio, followed closely by the MSCI EMU Index. Trailing both by some margin over the same periods is the EURO STOXX 50 Index. While the breadth to risk-adjusted performance relationship may not hold over shorter time horizons, we are confident that broader indexes will demonstrate their superiority over longer time frames.

Like in most other developed markets, over the trailing 15 years, mid- and small caps have outperformed their larger counterparts. This has seen blue-chip stocks surrender a percentage of overall market to their smaller counterparts, increasing the importance of capturing the eurozone mid-cap segment.

In theory, mid- and small caps have a greater growth potential than their larger, often more mature counterparts and are expected to grow more rapidly in up markets. Conversely, they are riskier (fewer eyes on their financial dealings, less diversified revenue streams, less credit available, and so on) and likely to be hit hardest in market downturns.

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Alternatives

The Euro Stoxx 50 Index is the most widely tracked index to gain exposure to eurozone equities, so there are plenty of alternatives available. Providers offering Euro Stoxx 50 ETFs include (but are not limited to) iShares, Lyxor, Invesco, and HSBC.

Xtrackers offers a distributing Euro Stoxx 50 ETF for an identical fee of 0.09%. Another good option is iShares Core Euro Stoxx 50 ETF. Both its accumulating and distributing share classes have an ongoing charge of just 0.10%, and it is also among the best-performing Euro Stoxx 50 ETFs on offer.

Investors looking for more-comprehensive exposure to eurozone equities, including large- and mid-cap stocks, can consider ETFs tracking the MSCI EMU Index. ETFs tracking the Euro Stoxx Index will additionally provide some small-cap exposure.

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